What is a Financial Annuity?
A financial annuity is a contract between you and an insurance company. You pay the insurance company one or more premiums to purchase the annuity. In exchange, you receive a guaranteed future payment or payments from the insurance company. The amount of the payments will depend on the type and size of annuity you purchase and the interest rate or investment return of the annuity. Although a common use for annuities is to set up retirement income, you can purchase annuities for other reasons.
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Premiums
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You can pay the premiums for an annuity in two ways. With a single-premium annuity, you pay the insurance company one large premium payment to buy the annuity. With a multiple-premium annuity, you make monthly, quarterly, bi-annual or annual premium payments for a length of time specified in the annuity contract.
Immediate or Deferred
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With an immediate annuity, you begin to receive income payments within one year after you pay the premium. With a deferred annuity, your income payments start many years later.
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Fixed Annuities
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Fixed annuities are the most secure option. The insurance company not only guarantees your principal (the amount you paid in premiums), but also guarantees a minimum interest rate, based on the annuity you purchase. You have two income options with a fixed annuity. You can receive a lump-sum payment, or you can receive equal payments over a time period you select, including the rest of your life.
Variable Annuities
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Variable annuities can grow in value or lose in value based on the investments made by the annuity. Variable annuities let you choose from various investment options, which can range from conservative to aggressive. Plus, the transfers between investments are tax-free. Your income options are a lump-sum payment, equal payments over a selected period, or a fixed or variable stream of income.
Considerations
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Like all investments, annuities have costs and risks associated with them. Especially with variable annuities, make sure you understand the investment objectives, risks, charges and expenses and the annuity's underlying investment options. When you receive your annuity payments, part of each payment is investment income and part of each payment is a return of your initial investment. The return of your initial investment is not taxable, but the income part of the payment is taxable.
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